Modern Identities and Misguided Mergers

The fun and, often, the tragedy of writing about the internet and its sub-biomes in 2018 is that something you wrote a week ago may be rendered obsolete and antiquated within a few EC2 clock cycles. That or Ben Thompson writes a piece on the same subject that makes yours pale in comparison. Positions that may seem innovative and forward-looking one week may seem quaint and common knowledge the next.

A couple of months ago I wrote Media’s Big Bifurcation, and I’ve been thinking about the topic at length ever since. I also happened to write that piece on the eve of a federal judge’s ruling to allow AT&T to proceed with its bid to acquire Time Warner. Despite the fact that that ruling will undergo a token appeal process, it is widely expected to close, which will define the landscape upon which all media companies compete for the next three-to-five years. Given how rapidly this space is changing, I’m probably underestimating the length of that time period and the overestimating the impact of the ruling.

In this post, I’ll talk about what I think that landscape looks like and why AT&T really doesn’t have a reasonable shot of being a driving force upon it.

You Are What You Eat

The AT&T deal is endlessly fascinating. At its core, it’s a merger between a vertical distributor and a horizontal content producer. I’m struck by just how per-ordained the whole thing feels: AT&T is showing that old-line media companies still have little conception of what motivates modern media consumption, but the move is also the only one that AT&T could make. It had no choice. The only way for AT&T to move forward was by leveraging the scale of its distribution networks to enable and prioritize its newly-owned production capabilities.

The real issue, as I see it, is that media consumption has become inextricably linked with identity. I think most people have a good idea of the existence of that relationship but don’t fully comprehend its scale and scope. Facebook and Google have built massive businesses by delivering content that is tailored for (and by) their users’ online identities. The news we watch is driven by our political identity, the content we consume on Snapchat and Instagram is driven by our social identity, the ads we see are linked to our consumption identity, and the video we watch is driven by some combination of all three. This is truer now than at any time in recent history. We are what we eat.

Which brings up the point – what does it take to make a valid claim on someone’s identity? I’m trying to define the relationship between a provider and a consumer: knowing that the provider/creator hopes to have a good idea of who is on the receiving end, what exactly does it take for that provider to have a valid notion of that consumer’s identity? That claim can either be made by the consumer providing data (passive) or by providing dollars to forgo the need to provide data (active). Although the point is slightly more nuanced, you can simplify by dividing on whether or not a service is free or paid.

Consumers differ from businesses in their consumption patterns in that they ‘make decisions based on factors outside of whether the product solves their problem.’ Consumers make decisions based on factors outside their apparent utility functions. I think that most people ultimately use a service because they are told to. And the most likely place to be told to do something is on one of the main services you already use (Google, Amazon, Facebook, Apple). The ability of these companies to unite and incentive actions across a wide range of jointly connected services has helped them reach a market cap of over $600B at the time of writing.

The sum of a user’s actions across the properties of one of these companies is what I call a consumer’s identity cloud; digital interactions and events which create a feedback loop of consumption and enablement across a wide range of services. The cloud is often used when speaking about software delivery, but the concept is just as applicable here. I took a minute and wrote down all the things that an identity cloud contains and came up with the below list:

Payment info

Photos / video / music / books

Preferences (spanning media preferences to demographics used for ad identities)

Voice assistants

Notes

Calendars

Purchases

Travel info

Email

Tasks

Avatars (online identities like Bitmoji)

Health info

SSO to other websites (basic info portal)

Smart home info

Location data

Large tech companies have touch points on each of the bullets above and I’m sure you could think of many more.

This is all supposedly done in the name of the consumer. But if we are what we eat, what then is AT&T, on the cusp on subsuming Time Warner?

Horizontal, Vertical, and Backwards

The media world has had a remarkable reshuffling in the past decade, to say the least. However, the past few months have been filled with enough plot twists, partnerships, and misguided mergers to make the last ten years seem tame in comparison. This year has been the year that old media distributors, providers, and conglomerates – the Time Warners, Fox’s, Comcasts, and AT&T’s of the world – finally put their foot down and loudly proclaimed that while they still had only a vague understanding of what incentivizes consumers in the 21st century, that wasn’t going to stop them from making last-ditch efforts to dictate the way we will consume content over the coming years.

In 30 seconds, here’s a quick timeline of recent media mergers:

September 2016: Shari Redstone calls to merge CBS and Viacom

May 2017: Sinclair Broadcast Group announces its intent to buy Tribune

July 2017: Discovery buys Scripps Networks

May 2018: CBS and Viacom trying to merge again with a perceived end goal of selling to Verizon or Amazon

July 2018: Ajit Pai comes out in opposition to Sinclair-Tribune merger

The ruling by an antitrust judge to allow the merger of AT&T and Time Warner means there is no longer any distinction between content creators and distributors. Companies must do both, well, to be a player in the current media world. At the risk of oversimplifying a massively complex issue, I’d like to break this down into a couple points:

There is no longer any middle ground between massive scale and being a small nimble player

Netflix just came out publicly and said their content budget for 2018 would be $13 billion, which is $5 billion over the $8 billion that they had previously planned to spend. The company that can predict if you’ll like a show with near-perfect accuracy underestimated its own budget by nearly 40%. (Update (8/12): I read some more about this and I think a lot of the misalignment here is due to how Netflix amortizes it’s content investments. Regardless, the point still stands). All the mergers I listed above are with the intention of increasing surface area and scale. Entertainment bundles will get bulkier and more unwieldy.

Meanwhile, smaller players either have limited claim on identity (see You Are What You Eat) or they lack budget. As I mentioned in Media’s Big Bifurcation, Cash-strapped and nimble companies alike will avoid competing in this space, simply because the only game in town is massive budgets funded on the assumption that revenue per use (RPU) will increase into perpetuity. Smaller companies can’t play that game, so they innovate in other ways. There is no middle ground.

It doesn’t matter that most of the original content on Netflix is crap – as long as the amount of content they produce keeps growing, to succeed they only need a fixed percentage of that to stick (Netflix also has AT&T’s HBO beat in this race):

AT&T / Time Warner is a vertical/horizontal merger that creates very little additional leverage

I think that vertical media companies are emboldened by the net neutrality repeal. However, they fundamentally misunderstand a few key points in addition to the notion of consumer identity + new media spending.

A massive firm like AT&T tightly integrates through the value chain and controls all aspects of its product, from owning the hardware used to provide cell service all the way through to managing the end customer relationship. A content provider like Time Warner distributes its media properties across all sorts of devices and end customers. AT&T builds a more successful business by using integration throughout the value chain to cut costs and deliver a better customer experience; Time Warner succeeds by getting its content onto as many screens as possible.

This excellent HBR article from 2016 is prescient about the rising new media players: “(Apple, Twitter, Facebook, Amazon) are market-share leaders in advertising, hardware, e-commerce, and social networking. These are businesses competing on networks and connections. For them, content isn’t core, but it is an important complement. Each of those companies is betting that it doesn’t need to buy a media powerhouse (but) can acquire content at a lower price by partnering, producing content itself, or by seeking out content from digital publishers and millions of other sources.”

AT&T is acquiring content through traditional M&A because it doesn’t have the aggregation power to drive publishers to creates for its services free of charge. When really, content creation and purchasing should be viewed as a venture investment. One of the defining characteristics of venture investments is that they follow a power law curve, meaning among other things that a small number of hits make the vast majority (90%+) of returns. Netflix just needs 10-20% of its content to succeed massively to make the strategy work. AT&T may try to bundle the content with its other services (in effect lowering the price of the content), but any gains in subscribers there come at the expense of Time Warner’s profits. This is a zero-sum game. AT&T could try to develop a novel delivery of original content, but we’ve seen how telecom companies do at that strategy.

In old media’s mind, the war for eyeballs will be won by vertical mergers emboldened by the recent repeal of net neutrality. It will be won by jamming dozens of channels which are the TV equivalent of flyover country into licensing deals which force consumers to continue paying for 50x the content they actually want. It will be won by raising prices on the only semblance of a modern OTT content offering they have. Modern consumption patterns are enabled by information identities which are themselves an amalgam of all activity we do online and AT&T has only a vague claim on all of that.

In my next post (coming within a week!) I’ll talk about what AT&T did after the Time Warner deal and cover why it may all be moot anyway.